What is an LLC?

An Limited Liability Company or LLC is a hybrid business structure that takes cues from both a sole proprietorship and a corporation. An LLC is a legal entity, meaning courts and laws will recognize the structure, but it is not a tax entity, meaning when filing taxes, an LLC will have to designate itself as a sole proprietorship, an S-Corp or a C-Corp, which you can learn more about below.

An LLC is generally formed to help protect a small business owner’s personal assets or to help the business have more opportunities to grow. Tweet This  Many small businesses can benefit from becoming corporations, but an LLC is an equally viable option for many small businesses. When trying to decide on a business structure, it’s best to consult with a professional.

Why choose an LLC over a Sole Proprietorship or Corporation?

If you choose to incorporate your business, you’ll have to choose between becoming an LLC or a corporation. If you choose not to incorporate, you’ll be established as a sole proprietorship. So, which do you choose?

  • If you do not incorporate and operate as a sole proprietorship, your personal assets may be put at risk. You’ll also face some other challenges, for example, you might face difficulties getting funding or contracts.
  • If you incorporate as an LLC, your personal assets will largely be protected, and you can have an easier time building business credit, which can help you with loans.
  • If you decide to form a corporation, you’ll have to choose between becoming an S-Corp or a C-Corp, both of which come with their own challenges and legal issues, and you’ll have to meet the qualifications for either one as well.

The top reasons small businesses choose to incorporate as an LLC instead of a corporation or sole proprietorship are usually:

Once you incorporate as an LLC, you can actually choose the way you want to be taxed (as a Sole Proprietor, S-Corp, or C-Corp, if you qualify), which enables you to pick the taxation that will best benefit your business and your members. For example, if you choose to be taxed as an S-Corp, you won’t be subject to double taxation like C-Corps are, which is generally a better option for a small business. With an LLC, you can also dictate how your profits are divided amongst your members. In an S-Corp, profits have to be divided amongst shareholders according to their contributions, but in an LLC, you can decide to give all members equal share despite their levels of contributions. LLCs are the most flexible of the business structures because they are relatively new, and this flexibility can greatly benefit a small business.
One of the biggest reasons small business owners choose to incorporate their business is to help protect their personal assets. As an unincorporated sole proprietor, there’s no distinction between you and your business; you are considered the same entity. Which means if something goes wrong with your business, your personal assets could be seized, or your personal credit could be harmed. To counteract this, small business owners often incorporate as an LLC to create a distinction between themselves and their business, even if they still operate exactly the same way as before they incorporated. Becoming an LLC also opens the door to building business credit, which can be especially hard for a sole proprietor. Learn more about the benefits of building business credit below.
Trying to get a loan (or a contract) as a sole proprietor can be difficult and full of risk, since personal credit and assets can be involved. But since an LLC is a separate entity, banks may be willing to loan to the business without involving personal assets, and if the LLC has strong business credit, it may be able to get better terms and conditions, or take out a bigger loan. When trying to get contracts, others may be more willing to work with a business than with an individual, and being able to provide a distinction between yourself and the business could help you get more clients.

Challenges facing LLCs

Despite the vast benefits that can come with incorporating as an LLC, there are still challenges to face. Choosing how to be taxed will be a challenge in itself, (and you should seek professional guidance), but more challenges can lie ahead. If you think you may want to pursue investors, for instance, you may struggle as an LLC. Because LLCs have members who split the shares of the company, when an investor buys a share, it has to come from one or both of the members, and the investor will have to file the profits on his or her tax return. Because the investment process is not as simple with an LLC as it is with a corporation, investors tend not to work with LLCs.

Another challenge LLCs face is the legal system. Since the business structure is still relatively new, there aren’t as many cases to turn to when trying to rule on an LLC case. Corporations have been around for a long time, and courts have countless cases to look to for guidance, but that’s not true for LLCs, and while many states have similar LLC laws, there are still some differences between states, which could cause problems for small businesses if they open new locations or do work in multiple states.

How to Build Business Credit as an LLC

As an LLC, your business won’t face as many challenges as a sole proprietor would when building business credit. Sole proprietors can’t make a legal distinction between themselves and their company, which can also mean no distinction between their personal credit and their business credit. But, as an LLC, you can be able to get loans, credit cards, lines of credit and contracts in your business’s name, which can help you to build business credit.

You may not work with many other businesses or have many contracts as an LLC, depending on your type of business, but if you do, this can also help you build your business credit. By having the vendors you work with report to credit reporting agencies like Dun & Bradstreet, you can help show that your business is credible and reliable. Plus, adding positive payment experiences to your business credit profile** can help impact your scores and ratings, which is what lenders and other companies will likely be looking at while evaluating your business.

By being able to build strong business credit as an LLC, you may help increase your chances of getting a small business loan, and you can help minimize risk by protecting your personal credit and assets.

Managing Risk as an LLC

Luckily, as an LLC, your personal assets can be largely protected. But, you may still face other risks. You’ll want to make sure you seek professional guidance to help avoid risks with your taxes, and day-to-day operations to help prevent lawsuits. While an LLC can generally protect a business owner from financial debt risk, it doesn’t protect the owner from everything. If the LLC is found to be negligent (not implementing proper safety standards) or to have made fraudulent statements, the owners or members can still be held liable. And, in the case of LLCs, worker’s compensation liability falls on the members/owners of the LLC, unlike with a corporation where the owners are protected. On top of these major risks, there are also things like cyber security and insurance risks to worry about. Learn more about minimizing risk as a business owner to help protect your company.

Using Business Credit to Manage Risk

Since you can build business credit as an LLC, you may as well use it to its full advantage. Your business credit can also help you manage risk. By regularly monitoring your business credit file you’ll be able to see any changes to your information, and if you didn’t make the changes, you can investigate any potential fraud before it harms your business. If you do end up working with other companies, you can check their business credit files to help anticipate any late payments or defaults. You can also monitor your scores and ratings to help make sure that when you need to ask for funding, you’re in a good position to do so. Your business credit can help give you a great deal of foresight, which can help you protect and run your business better.

Photo Credit: lorenklein, Twenty20